The title as well as some of the commentary below is from Dr. Robert Schneider.
Schneider has been an important figure in American foreign policy and global security during the Reagan and Bush 41 years. Dr. Schneider and myself enjoyed a great conversation about the following article with another CEO/economist from out West. [I have not yet obtained permission to name the Western CEO as of yet but he is described as having an “Obscene IQ” as I am confident his clients will attest to.]
Normally I do not share such conversations, but this one is such a valuable exploration of current public policy I made an exception. Keep in mind that what you are about to read is a conversation that is completely spontaneous. What you are about to read is an intellectual feast. Enjoy!
Dr. Schneider: I find most the folks on here trying to use “logic” to make arguments, without understanding the fundamental principles underpinning the Ryan plan. The dems argue we have to have stimulation (not Anthony Weiner’s type) to get the economy going again. Here is the argument which the other side can’t counter. Of course, the Ronulans wouldn’t know an economic argument from a sack of worms, but it might be fun to watch their heads explode as you lay this article on them. It is the knockout punch.
For our arguments to win the day against liberals, and others who may think it’s ok to bash Ryan, these arguments are key to getting us back to a prosperous nation, and out of our economic gloom.
Ugly Modeling: Will spending cuts ruin or improve America’s economy?
By Veronique de Rugy
From Reason Magazine
In February, the Goldman Sachs economist Alec Phillips predicted on ABCNews.com that a Republican proposal in the House of Representatives to cut $61 billion from the federal budget in fiscal year 2011, would, if enacted, shave two full percentage points off America’s gross domestic product in the second and third quarters of this year. A few days later, The Washington Post described a new study by Mark Zandi, the chief economist at Moody’s Analytics and an architect of the 2009 stimulus package, a.k.a. the American Recovery and Reinvestment Act. Zandi’s amazing verdict: The spending cuts would destroy 700,000 jobs by the end of 2012.
After every newspaper had published the gloomy predictions, Goldman Sachs issued a “clarification” of Phillips’ analysis. Phillips now says he was misunderstood by journalists eager to spread a doom-and-gloom message and predicts the impact of spending cuts probably will be mild and temporary. Perhaps he was influenced by Federal Reserve Chairman Ben Bernanke, who testified in March at the Senate Banking and Urban Affairs Committee that Goldman’s numbers were incorrect.
Yet even this correction implicitly assumes that government spending is the source of all recovery. The logic, as with Bernanke’s and Zandi’s analyses, is that government spending cuts reduce overall demand in the economy, which affects growth and then employment. This argument ignores the fact that the government has to take its money out of the economy by raising taxes, borrowing from investors, or printing dollars. Each of these options can shrink the economy.
All these analysts also systematically ignore the fact that GDP numbers include government spending. When the federal government pumps trillions of dollars into the economy, it looks as if GDP is growing. When government cuts spending—even cuts within the most inefficient programs—aggregate GDP shrinks.
But that’s misleading. If Washington spends $1 a year on a bureaucrat’s salary, for example, GDP numbers will register growth of exactly $1, whether or not the employee has produced any value for that money. By contrast, if a firm pays an engineer $1, that $1 only shows up in the GDP if the engineer produces $1 worth of stuff to sell. This distinction biases GDP numbers—and the policies based on them—toward ever-increasing government spending.
Furthermore, GDP does not capture changes in personal investment portfolios or changes in private research and development spending. In the last two years, corporate cuts in the latter area have been large but unaccounted for. Also not included in GDP: pension benefits and the U.S. Flow of Funds Accounts balance-sheet information from the Federal Reserve Board. That means that when it comes to GDP, states’ grossly underfunded pensions are off the books, along with the loans and purchases conducted under TARP.
Another problem with these analyses: Economists of all persuasions have proven to be really bad at predicting the future, especially when it comes to jobs. Take the stimulus. Forecasters at the White House and the Congressional Budget Office (CBO) predicted the stimulus package would create more than 3 million jobs. And in August 2010, the CBO estimated that the stimulus had indeed created between 1.4 million and 3.6 million extra jobs, thrilling supporters of economic intervention. But unemployment stubbornly remained around 10 percent.
What was wrong with the CBO’s numbers? “When the upper limit of your estimate is almost three times the lower limit, you know it is not a very precise estimate,” the George Mason University economist Russ Roberts pointed out in testimony to the House Subcommittee on Regulatory Affairs, Stimulus Oversight, and Government Spending in February.
The truth is that there is no way to know the real number of jobs “created or saved” by the stimulus. For that, the CBO would have had to collect data on output and employment while holding other factors constant. But the CBO didn’t do that because that’s different from its job of “scoring” the possible results of proposed legislation. As the CBO explained in a November 2009 report, “Isolating the effects would require knowing what path the economy would have taken in the absence of the law. Because that path cannot be observed, the new data add only limited information about [the law’s] impact.” In other words, CBO number crunchers gave it their best guess before the stimulus and arrived at their subsequent numbers by applying their original prediction model. If the model is wrong, so are the numbers.
No one knows what economic output would have been without the stimulus, and no models can tell us the answer. As Roberts testified, “The economy is too complex. Too many other variables change at the same time.”
Also, the Zandi and Phillips models are based on the Keynesian view that government spending produces recovery. According to that theory, $1 in government spending produces substantially more than $1 in growth, a phenomenon known as the “multiplier effect.” The Goldman Sachs study assumes a multiplier greater than three—i.e., more than $3 in additional GDP for each dollar of government spending. But a review of the empirical literature reveals that in most cases a dollar in government spending produces less than a dollar in economic growth. And these findings often don’t even take into account the impact of paying for that government dollar via increased taxes.
The Harvard economists Robert Barro and Charles Redlick estimate that the multiplier for stimulus spending is between 0.4 and 0.7. In another study, the Stanford economists John Taylor and John Cogan concluded that the stimulus package couldn’t have had a multiplier much greater than zero. Even the multipliers used by Christina Romer, the former chairwoman of the White House Council of Economic Advisers, and Jared Bernstein, economic adviser to Vice President Joseph Biden, in their January 2009 paper “The Job Impact of the American Recovery and Reinvestment Plan,” ranged from 1.05 to 1.55 for the output effect of government purchases. More recently, the Dartmouth economists James Feyrer and Bruce Sacerdote, who supported the stimulus, acknowledged that it didn’t boost the economy nearly as much as the administration models claimed it would.
The use of these outdated models and unrealistic multipliers explains why Zandi was wrong about how many jobs the stimulus would create. He claimed “the country will have 4 million more jobs by the end of 2010” if the stimulus passed. In truth, by the end of 2010 total payroll jobs had fallen by 3.3 million, and the unemployment rate had risen from 7.8 percent to 9.4 percent. The administration’s post-facto claim is that unemployment would have risen even more without the stimulus. To argue this, they again must pretend that they know what would have happened in the absence of a stimulus.
Now what? Many economists and many members of the business community argue that recent policy changes have hampered investment, making a bad situation worse. The prospect of endless future deficits and accumulating debt raises the threats of increased taxes and of government borrowing crowding out capital markets, diverting resources that could be used more productively. As a result, U.S. companies are less likely to build new plants, conduct research, and hire people.
We have tried spending a lot of money to jump-start the economy, and it has failed. Now we need to cut spending and lift the uncertainty paralyzing economic activity. That approach will not just be more fiscally responsible. It will also empower individuals and entrepreneurs. And they are the only ones who can bring on a real recovery.
Ms. de Rugy (email@example.com), a senior research fellow at the Mercatus Center at George Mason University, writes a monthly economics column for reason.
IUSB Vision Editor Chuck Norton: This article above is a VERY good argument, but even so I would add just a couple of minor points (and thoughts).
The Keynesian GDP formula also assumes that government spending is better than consumer or even capital investment spending because people in the private economy will save some of their money and not spend it. Keynes calls this “leakage”.
This concept almost completely ignores the fact that savings have a positive impact on the economy in several ways. If you save the money in a CD the banks have more depositors’ money that can be used for loans and it helps to ease the credit market. Money saved in the form of bonds or stocks or other investing has obvious positive effects that are not measured PROPERLY in the Keynes GDP formula as it is only a dollar per GDP measurement and investment dollars for production have a much larger impact – this is literally where the creation of wealth comes from.
The other impact that savings have in an economy is psychological. Are you more likely to buy a car, or a durable good, or take a risk with an investment if you have more savings? The impact of “confidence” on the economy is difficult to overstate.
The economist Art Okun describes what he called “Okun’s Leaky Bucket” when it comes to government spending. When government spends or redistributes wealth, some of the money just goes poof. It is more than the decreasing incentive for the productive to work when they are punished or the money that is eaten up by the bureaucracy; government spending is just less efficient period for a number of reasons, so the Keynesian dollar per GDP formula critiqued in Bob’s posted article is even worse than the article explains.
When you (or a business) use a dollar it is spent on the greatest need or want. In the macro this results in great efficiency because dollars are going where they are needed/wanted the most. Government spends money for political reasons, corruption, and “make work” central planning. Those dollars are not spent to “produce with maximum efficiency and impact”, they are spent in the hopes that some of it returns in the form of campaign contributions.
When money is used for production to actually make things, especially capital goods, the velocity of those dollars expands greatly, and while it is doing the maximum good in creating wealth, those dollars are taxed more times as they move through various hands and government revenue increases. It is a win/win.
The Keynesian GDP formula assumes that government spending is equal to or better than capital investment spending and such a notion is laughable on its face.
Assume for a moment that we have an economy of 1000 men making widgets. Just to pick a round number lets say they have a GDP of 1000 units. The GDP is equal to the combined productive output within nation’s borders in a year. Enter “The Bernanke” who prints up 100 units and enter “The Pelosi” who spends those 100 units. Congratulations! Now on paper your production just went up to 1100 units of GDP. See how much MORE productive we are!
In reality you still just have 1000 widgets. The increase in GDP is a fantasy. A new GDP formula is needed.
Western CEO/Economist: 100% of the time government stimulus has failed to truly stimulate. Sure, buying a ton of office supplies helps out International Paper, Staples, etc. however it is a $1 gov spends does NOT turn into a $1 in taxation, usually less than 20%.
However, that same $1 in the private sector the velocity of money is accelerated. Also, it is not money spent by government that it has, it must borrow it and that is in essence $2 dollars. Dollar spent and dollar borrowed.
Art Laffer, Milton Friedman, etc have proved that reduced tax rates has a much better stimulative effect on real GDP than any other single measure and it is a LASTING measure. Bush tax cuts took us IMMEDIATELY out of the Clinton (fairly cyclical) recession.
Another thought: the way to have REAL GDP growth is in building: Homes, offices, cars, ships, etc. Without real construction growth (not possible with frozen credit markets) you cannot have sustained GDP growth. Money Supply is growing at 12% or higher with GDP at maybe 1.5%. That is financial suicide.
I am NOT afraid of the border, Al Qaeda, etc, I AM afraid of this massive debt.
Chuck Norton is dead on. Fellow economist? Keynes was uber bright for the TIMES. HE is dated, just like the Austrian boys Hayek and von Mises, both uber bright but not for a truly global world.
Dr. Schneider: V= nQ/M some things you just never forget.
CEO/economist: Most econ theory is just that, theory. Milton taught us to THINK. Free markets ALWAYS chose the right winner. It is when gov makes winners and losers that the tax payer pays and pays…….
Phil Donahue interview of Milton Friedman:
Donahue: When you see around the globe the mal distribution of wealth the desperate plight of millions of people around the world in under developed countries. When you so few haves and so many have not’s when you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism and whether greed is a good idea to run on?
Milton: Well first of all, tell me is there some society that you know of that doesn’t run on greed? Do you think Russia doesn’t run on greed? Do you think China doesn’t run on greed? What is greed? Of course none of us are greedy; it is always the other fellow that is greedy. The world runs on individuals pursuing their separate interests. The great achievements of civilization have not come from government bureaus! Einstein did not construct his under order from a government bureaucrat! Henry Ford didn’t revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history, is where they have had capitalism and largely free trade! If you want to know where the masses are worse off is in the exact society’s that depart from that [sic] free trade and capitalism. So that the record of history is absolutely clear that there is NO alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by the free enterprise system.
Donahue: But it seems to reward not virtue as much as the ability to manipulate the system.
Milton: And what does reward virtue? Do you think that the communist commissar rewards virtue? Do you think a Hitler rewards virtue. Pardon me, but do you think American Presidents reward virtue? Do they choose their appointees on the basis of virtue of the people appointed or on the basis of their political clout? Is it really true that political self-interest is nobler somehow than economic self-interest? I think that you are taking a lot of things for granted. Just tell me where in the world do you find these angels who are going to organize society for us?….
Dr. Schneider: Markets are smarter than people.
Chuck Norton: I have to tell you guys this funny story in light of Bob’s last comment “Markets are smarter than people”.
I got into an argument with a Marxist prof who was all about central planning and not leaving people’s livelihoods to chance (the market) and insisted that a more rational top down approach was safer and fairer.
So I said to the prof, OK, let’s make a society of 10 million people and you can pick the ten smartest people through all of recent history to plan this economy. Assume that you are in a place with adequate resources to serve the population reasonably. Please pick your 10.
She picked her ten. They were all men with names many would know. I answered, OK now tell me which one of these men will be the central planner in charge of tampons and maxi pads (Laughter). [Markets are smarter than central planners with good intentions, or bad ones – Editor]